*4.1.8 The Granger causality test*

The Granger causality test is used to determine the causal relationship of each variable with other variables. The test level used in the Granger causality test is the level of confidence (α = 0.05) with lag length 2, according to the optimal lag length that has been done previously. Results of the Granger causality test are as follows.

**Table 14** shows the causality between variables with various probability values. The findings suggest that the variables have one-directional relationship, namely:



risk exists if Islamic banks fail to settle operational problems, especially in the long run.

that there is a small contribution of risk variation from financing risk to liquidity risk. Therefore, overall findings suggest that Islamic banks are resilient in absorbing shocks when financing side is vulnerable. In other words, Islamic banks are not sensitive to risk originated from financing side as its liquidity is sound. In addition, the findings elaborate that the liquidity management on Islamic banking in Indone-

**Table 15** demonstrates the relationship of liquidity risk with other risks. The Granger causality test suggests that liquidity risk has a directional relationship with financing and operational risks. Given that liquidity risk is affected by other risks, generally it was affected negatively in the short run and positively in the long run, but did not show a significant sign according to VECM estimation. The IRF further explains that even though the liquidity risk gets shocks originated from financing and operational risks, Islamic banks remain resilient. The VDC results also

strengthen the findings that the variation on liquidity risk is negligibly contributed by financing and operational risks. In other words, financing and operational risks

**Table 15** shows the general performance of operational risk on Islamic banks in Indonesia. According to the Granger causality test, operational risk exists in Islamic banks where it was influenced by financing risk and liquidity risk. The former indicates that Islamic banks are sensitive toward operational risk particularly due to failure in repayment counterparty obligations. This condition is supported by some empirical evidences including the following: (1) VECM estimation suggests that there is a positive relationship between financing and operational risks only in the short run, but not in the long run. This implies that Islamic banks have adjustment capacity to settle their operational problems when financing problems exist; (2) IRF result explains that operational risk is quite sensitive in Islamic banks as the variation in operational risk is highly contributed by financing risk according to VDC estimations. In short, operational risk in Islamic banks is connected with the ability of Islamic banks to manage their financing allocations. In other words, financing

The latter shows that liquidity risk has a directional causal relationship with liquidity risk. However, some empirical evidences suggest operational problems in Islamic bank are not closely affected by liquidity risk. For example, VECM estimation found no positive and significant influence in either short or long run and small portion variation of liquidity due to operational problems. It implies that liquidity management in Islamic banks is strong and sound in absorbing any shocks from operational risk. In other words, operational risk does not matter for Islamic banks,

Islamic banking in Indonesia is a new institutional approach in promoting economic development. Although its shares are small, it has been growing rapidly and now becomes a new national policy in spreading growth and prosperity. Islamic banks, technically, have two sides, funding and financing, which are operationally connected and integrated. Given this condition, the potential risks are quite large to

**5. Conclusion, research limitation, and further research**

do not matter for Islamic banks, especially related to liquidity side.

sia is strong and resilient against financing risk.

*Risk Analyses on Islamic Banks in Indonesia DOI: http://dx.doi.org/10.5772/intechopen.92245*

*4.2.2 Liquidity risk*

*4.2.3 Operational risk*

risk matters for Islamic banks.

particularly related to liquidity side.

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c. There is one-directional relationship between NPF and BOPO. It means that the vulnerability in Islamic banks due to operational risk is empirically caused by financing risk. This finding strengthens the previous results that operational risk is positively affected by financing risk, either short or long term, with a quite high degree of contribution.

In short, empirically the risks in Islamic banks are mainly caused by financing risk. The one-directional relationship implies that bank's vulnerability exists due to the inability of the bank to manage nonperforming financing. Bank's balance sheet is vulnerable toward any disruptions on financing problems. It is rational in the midst that Islamic banks have limited funds than conventional banks and offer various Islamic contracts. These conditions enable Islamic banks to face systemic risks when a problem occurs on the asset side as both sides are connected according to the bank's balance sheet flow process.
